©2005 Carlson Marketing Group, Inc. All rights reserved. Peppers & Rogers Group is a Carlson Marketing Group company. Return on Customer sm and ROC sm

©2005 Carlson Marketing Group, Inc. All rights reserved. Peppers & Rogers Group is a Carlson Marketing Group company.

Return on Customersm and ROCsm are registered service marks of Peppers & Rogers Group

Who Moved My ROI?Building the Value of the Customer

and the Company

Stichting Marketing Foundation-Gent December 3, 2005

Martha Rogers, [email protected]

©2005 Carlson Marketing Group, Inc. All rights reserved. Peppers & Rogers Group is a Carlson Marketing Group company. 2

You tailor your product, service or interactions

Customer talks with you

FEEDBACK

Saveme

time

The more effort a customer invests, the greaterThe more effort a customer invests, the greaterhis stake in making relationship workhis stake in making relationship work

Going to a competitor = Going to a competitor = reinventingreinventing the relationship the relationship

The “learning relationship”


The antithesis to Learning Relationships: the “Goldfish Principle”

Some species of tropical fish have no capacity for territorial memory

Businesses operating on the Goldfish Principle have no customer memories— One U.S. hotel


A different dimension of business competition

Traditional Marketing

Market shareR

etu

rn o

n C

ust

om

ersm Share of

customer

Customer Needs Satisfied

Customers Reached

Maximize the financial return generated by each customer

Maximize the financial return for each product or each

marketing channel


Daimler’s prediction of automobile demand

Gottlieb DaimlerWorld’s first four-wheeled

gasoline-powered automobile

Limiting factor: A shortage of qualified chauffeurs


20th Century Marketing

Finding customers for the products available

Limiting factor: A shortage of paying customers

Today: more products, services, and channels


Where does all our revenue come from?

From products?

From salespeople?

From our brand?

No, it’s simple –

All our revenue comes from customers— Fact: Some customers are worth more than others— Actual and potential value— Value today and value tomorrow


Which is harder for a business to produce?

Products? Capital? Or customers?

OK, it’s obvious:—Customers are more scarce than products or capital—So why do we keep measuring only the profitability of

products? Why is the return on investment of money emphasized?

Customers are the limiting factor

You have to maximize the value created by each customer, not just the value of the financial investment


Maximizing enterprise value is similar to farming

9

Consider good Farmer Wilson

Wilson cultivates his land carefully


With conservation his land remains productive

10

It takes money to fertilize, to leave some land fallow, to cultivate in contours, and to rotate crops

But Wilson’s land will remain productive virtually forever


Contrast with bad Farmer Miller

Miller doesn’t practice conservation— He simply plants the most profitable cash crop every year,

on every available acre of land

— He saves money by reducing his fertilizer expenditures, and by avoiding crop rotation

In the beginning, Miller easily harvests more profit than Wilson does— But over time his land burns out


Short-term vs. long-term perspective Scary thought:

— In any given year, Wilson can always earn more by imitating Miller, and stopping his conservation

— But that would be stupid, right?

Well, remember the last 4th-quarter meeting?


Enterprise Creates Value Two Ways

Profits are harvested, and

Customer equity is created or destroyed

Needed: A metric to capture the effects of both types of value creation

Customers are the scarce resource

So what is the rate at which a company creates economic value from its customers?

Return on Customer


What is “Return on Customer”?

Customers are the scarce resource for a business» ROC measures true economic return on this resource

Consider the ROI on a portfolio of securities» Tally up dividend and interest income during the period» Then add in any increases or decreases in the value of the

underlying securities

But what if you only counted the income?

A company is like a portfolio of customers who» Buy things currently (current-period profit), and» Go up and down in value (changes in customer equity)


Excessive focus on the short term

Creates a culture of bad management— Not only leads to accounting scandals and fraud— But diverts managers from their primary responsibility:

preserving and increasing the value of the enterprise

Duke University survey of more than 400 senior financial executives in 2004:— 78% said their firm would give up economic value if necessary to

meet Wall Street expectations!

Short-term focus distorts how a company views the value that its customers create for it


Highly profitable bank:Market cap in Sept 2004 of $240b— Japan’s private banking clients generated less than 0.5% of the firm’s net

income – less than $100 million

But then: All the bank’s private banking in Japan was closed by regulatory authorities and in September Merrill Lynch downgraded the bank’s stock because: This company “might lack something that poses a threat to its future growth: a sense of right and wrong.”

Short-term gain, long-term loss

Bank’s stock price was doing well, and then…

$15 billion of lost value


ROC increases shareholder return

Fortune July

Best Buy is raising its “returns on specific customer segments”

May: Pilot test begun

Sept: Rollout announced

Programs like this result in Wall Street “rerating the P/E”


How Do Customers Create Value?

1. They buy things today, generating current sales and costs

2. They change their likelihood (today) of future buying and cost generation

Suppose a customer calls you with a complaint... Or makes a claim after paying for twenty years… It makes sense for a business to try to increase the value

that any customer creates This means changing the customer’s behavior

— The company must commit its resources to some campaign or other marketing (or other) activity

But what “resources” are required?

— We use money, of course, but also customers


ROC is Similar to ROI

Profit from customer + Change in value of customerProfit from customer + Change in value of customerStarting value of customerStarting value of customer

ROC =ROC =

Profit from investment + Change in value of investment Starting value of investmentROI =

ROI answers the question: How much value do you get for the moneymoney you have to use?

ROC answers the question: How much value do you get for the customerscustomers you have to use?

Both money and customers are used by a business when it creates more value


Which Resource Will You Run Out of First?Evaluating two possible

marketing actionsValue of

customerInvestment

required per customer

Net new value created per customer

ROI ROC

Treatment 1 $100 $10 $30 300% 30%

Treatment 2 $100 $40 $100 250% 100%

Cash available Customers affected

Net new value created

Treatment 1 $5,000,000 500,000 $15,000,000

Treatment 2 $5,000,000 125,000 $12,500,000

If cashcash is scarce

Customers available

Investment required

Net new value created

Treatment 1 300,000 $3,000,000 $9,000,000Treatment 2 300,000 $12,000,000 $30,000,000

If customerscustomersare scarce


ROI and ROC – Both measures together

Maximum ROI

Maximum ROC

Every possible treatment permutation

Increasing ROC

Incr

easi

ng

RO

I

ROI “hurdle rate”

Highest value creation


Warning: “Marketing” can destroy value!

Example: Start with a million customers

A marketing campaign generates a 1% response (10,000)— Cost is €1 per solicitation, or €1 million total— Each response generates €125 in LTV profit, or €1.25 million total — So each individual campaign is successful, with a €250,000 profit

But suppose non-responders become just 0.5% less likely to respond with each solicitation

Then with each campaign customer equity decreases by more than the “profit” harvested!


What do you mean – “use customers”?

Destroy equity by making money now at the expense of money later— Reduce the likelihood of future business

— Forfeit all chance of future business from one customer to make money from another

The DVD rental store fiasco that happens a million times a day

Scenario: Insurance agent as gatekeeper


The agent who cost money with every sale

Company Y sells auto, property, health and life insurance Agents recruit customers, then are protected from

poaching by other Company Y agents Life and health are far more profitable lines But this agent does a terrific job winning new customers

for auto insurance...

How much value does Company Y lose every time

this agent recruits a new auto customer?


Verizon’s wireless division generated $13.7 billion in operating earnings from 2002 to 2004 (Owned by Verizon Communications and Vodaphone)

But during this period the firm also cut monthly customer churn in half, from 2.6% to 1.3%

Cutting churn required balancing immediate profit against long-term customer satisfaction

Verizon created an additional $10.4 billion of value, in the form of increased customer LTV!

Average ROC during the period: 64%

ROC in Practice


Thinking about future customer buying... Customers have lifetime values

— Lifetime value (LTV) is simply today’s value of all future profits you predict you’ll get from a customer

When a customer’s likely future profits change, his LTV changes, also

The amount of the LTV change represents value created (or destroyed), right now

— Tracking LTV is important, but

— Measuring ROC means tracking changes in LTV

If a firm uses ROI alone, it might: — Miss the biggest opportunities to create value, or

— Unknowingly destroy more value than it is creating

To understand the total value created by customers, it’s necessary to measure changes in lifetime value

Tracking ROC is the best and most direct way toCreate maximum value for each customer


What if salespeople, service reps, account managers, and CEOs were penalized for the customer equity they have to spend today to achieve this quarter’s revenues?

What if Wall Street analysts held companies accountable for customer equity (as the best measure of enterprise value) as well as current revenue?

What if we could, and did, measure how much today’s

decisions really cost?


How do we build a customer’s value to us?

We become more relevant

So how do we do that?

We figure out a customer’s needs and meet those needs better than a competitor who doesn’t know what we know

Anticipate what customer needs

Take the customer’s point of view:—Tesco, Orica, Eneco, SPAR, ING Europe


Why do so many customer initiatives fail?

The information problem— Understand the whole value and need of each customer— Across products, services, geographies, touchpoints, and time

The strategy problem— Ready, fire, aim!— Do our customers belong to “marketing,” or are they the only source

of revenue for our company?— How do we measure the rate at which customers create value for our

company? How do we report it?— Who’s accountable for that? How do we manage it?

The adoption problem— Every employee decision and action creates or destroys value. How

do we build the ROC philosophy into everyone’s DNA?


Managing a firm’s “Customer Equity”

ROC means making a lot of marketing decisions, as well as non-marketing decisions, about how we do our job

Every management decision should be

made with an eye toward its impact on customer

equity


Taking the customer’s point of view means:

Treat Different Customers Differently

Relationships built on trust are the vehicle for customer-specific actions


ROC has two equally important aspects

An economic metric for calculating the rate at which customers create value— Calculating the real costs of abusive marketing

— Financial justification for a better customer experience, higher satisfaction, loyalty, etc.

A philosophy of doing business based on earning customers’ trust — Maximizing the value customers create requires

— Maximizing the value created for customers


Creating a culture of customer trust

“Treat the customer the way you would want to be treated if you were the customer.”

“No one tries harder for customers.”

“Our goal with our Fair Play program is to make ethics a natural part of our business”


Stena empowers its employees… Irish Sea routes – 3mm+ passengers annually, for years it had a fairly

bad service reputation

Today virtually 100% of passengers are asked about their satisfaction within 30 minutes of destination

— Different Stena staff inquire, try to resolve problems on the spot

Everyone on staff – all 600 people – anyone can elect to spend up to £1000 to satisfy a customer!


Creating a culture of customer trust

These companies are not just selling something.

They are building the value of the customer base.


First rule of ROC:

Return on Customer = Total Shareholder Return

Customer equity equals enterprise value for an operating company

Return on Customer: Six rules


Second rule of ROC:

Both long-term and short-term must be balanced

Don’t ignore the importance of short-term earnings!



Third rule of ROC:

LTV is important, but LTV change is the number you actually want

You need to identify the “leading indicators” of LTV change



Fourth rule of ROC:

Think and act in a customer-specific way

Customer relationships are required to maximize Return on Customer



Fifth rule of ROC:

Earn the trust of your customers

Customers don’t care about their value to you; they only care about what they need from you



Sixth rule of ROC:

Educate your employees and empower them to take action

Everyone has a different role to play, but the ROC metric provides a unifying objective for the whole organization. It’s everyone’s job to increase ROC.



Peppers & Rogers Group

[email protected]

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Now the strategic consulting arm of Carlson Companies, Minneapolis

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Toyama no Kusuri-Uri

House-to-house medical supplies

Consumers only charged for usage

Detailed records kept in a database, called the “Daifuku cho”

Circa 1750


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©2005 Carlson Marketing Group, Inc. All rights reserved. Peppers & Rogers Group is a Carlson Marketing Group company. Return on Customer sm and ROC sm